Economic Growth, Tax Receipts Combine to Reduce Deficit

Still, if the tax cuts are now yielding a rising tax take, the effect was certainly not immediate. The major tax cut of 2001 and further cuts in each of the last three years were followed by an unprecedented three-year decline in nominal tax revenues, from $2 trillion in 2000 to $1.8 trillion in 2003. Revenues recovered last year, reaching nearly $1.9 trillion. But at 16.3 percent of the gross domestic product, last year's revenue total, measured against the size of the economy, was the lowest level since 1959.

Robert Carroll, the deputy assistant Treasury secretary for tax analysis, was cautious about attributing this year's rising tax receipts to any single factor. It will be some time before the Treasury can decipher how much of the rush is attributable to capital gains and dividend taxes directly related to the Bush tax cut of 2003, Carroll said. But he did indicate the increased tax flow will be reflected not only in the administration's updated deficit forecast for 2005 but also in its long-term forecast when that is released July 15.

That has Democrats -- and some economists -- worried.

"My concern is you're going to have exactly this kind of talk, and what it does is undermine the real need, which is to cut the deficit," said Edward McKelvey, an economist and federal budget analyst at Goldman Sachs in New York. "That's dangerous."

Even a $300 billion deficit would be the third largest ever in nominal dollars, said John M. Spratt Jr. (D-S.C.), the ranking Democrat on the House Budget Committee. Moreover, the major budget challenges are yet to come. The Medicare prescription drug benefit goes into effect next year. The alternative minimum tax, which was created to ensure that the rich pay taxes but is now taking an ever larger bite out of the middle class, has yet to be permanently fixed. And war costs have still not been counted in future deficit projections.

"It's good news," Spratt said of the improving deficit picture, "but no one should assume it's going to continue, and above all nobody should get euphoric and assume we're going to grow our way out of this deficit."

Business investment and stock-price gains have slowed from last year, Holtz-Eakin cautioned, possibly indicating that the government is not seeing the kind of sustained tax gains that drove the deficit into surplus in the late 1990s. CBO is not likely to project the 2005 gains too far into the future, Holtz-Eakin said, especially considering that the huge liabilities of Medicare and Social Security remain unaddressed.

"I do hope people are taking this with a grain of salt and not thinking this is 1998 all over again," Holtz-Eakin said. "There's simply no question if you take yourself to 2008, 2009 or 2010, that vision is the same today as it was two months ago."